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Leverage and the Beta Anomaly

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  • Baker, Malcolm
  • Hoeyer, Mathias F.
  • Wurgler, Jeffrey

Abstract

The well-known weak empirical relationship between beta risk and the cost of equity (the beta anomaly) generates a simple tradeoff theory: As firms lever up, the overall cost of capital falls as leverage increases equity beta, but as debt becomes riskier the marginal benefit of increasing equity beta declines. As a simple theoretical framework predicts, we find that leverage is inversely related to asset beta, including upside asset beta, which is hard to explain by the traditional leverage tradeoff with financial distress that emphasizes downside risk. The results are robust to a variety of specification choices and control variables.

Suggested Citation

  • Baker, Malcolm & Hoeyer, Mathias F. & Wurgler, Jeffrey, 2020. "Leverage and the Beta Anomaly," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 55(5), pages 1491-1514, August.
    • Handle: RePEc:cup:jfinqa:v:55:y:2020:i:5:p:1491-1514_3
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    Cited by:

    1. William Diamond, 2020. "Safety Transformation and the Structure of the Financial System," Journal of Finance, American Finance Association, vol. 75(6), pages 2973-3012, December.
    2. Vinod Kumar, 2023. "Is the Beta Anomaly Real? A Correction in Existing Theories of Cost of Capital and Asset Pricing," Journal of Emerging Market Finance, Institute for Financial Management and Research, vol. 22(2), pages 135-163, June.
    3. Bradrania, Reza & Veron, Jose Francisco, 2023. "The beta anomaly in the Australian stock market and the lottery demand," Pacific-Basin Finance Journal, Elsevier, vol. 77(C).
    4. Bednarek, Peter & Franke, Günter, 2024. "Dynamics of probabilities of default," Discussion Papers 32/2024, Deutsche Bundesbank.
    5. Bradrania, Reza & Veron, Jose Francisco & Wu, Winston, 2023. "The beta anomaly and the quality effect in international stock markets," Journal of Behavioral and Experimental Finance, Elsevier, vol. 38(C).

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